The three most common types of business enterprise are sole traders, partnerships and public corporations. For example in 2004, in the UK, there were 514,820 sole proprietors (or sole traders), 309385 partnerships and 753020 companies and public corporations (Office for National Statistics, 2004). Of these 1,256 were listed companies. So far, in this page, we have focused on sole traders. Sole traders are, typically, relatively small enterprises owned by one person. Their businesses and accounts tend to be less complicated than those of either partnerships or companies. They are thus ideal for introducing the basic principles behind bookkeeping and final accounts. Here, we look at the profit and loss accounts and balance sheets of partnerships and limited companies.
Partnerships are normally larger than sole traders. However, basically their accounts are similar to those of the sole trader. This reflects the fact that partners, like sole traders, generally own and run their own businesses. For companies, however, the owners provide the capital, but the directors run the company. This divorce of ownership and management is reflected in the accounts of limited companies. In certain respects, particularly the capital employed, the accounts of limited companies thus appear quite different to those of partnership and sole traders. These differences are heightened by the fact that from 1st January 2005 listed companies in the UK and other European union countries had to follow accounting standards set by the International Accounting Standards Board (IASB).
In below photo, all types of companies have been compared.
Partnerships may be seen as sole traders with multiple owners. Many sole traders take on partners to help them finance and run their businesses. As in all human relationships, when partners are well-matched partnerships can prove very successful businesses.
However, when they are ill-suited problems can occur. Except for certain occupations (such as firms of accountants or solicitors) the maximum number of partners in the UK is 20. An important aspect of both sole traders and partnerships is that liability is generally unlimited. In other words, if a business goes bankrupt the personal assets of the owners are not ring-fenced.
Bankrupt partners may have to sell their houses to pay their creditors. Recently, however, for professional partnerships, particularly accounting partnerships, a new organisational form, the limited liability partnership (LLP), has been created. For these organisations, liability is capped. Sole traders and partners prepare accounts for use in their own personal internal management, but also for external users, such as the tax authorities and banks. The key issue which underpins partnerships is how the partners should split any profits. The ratio in which the profits are split is called the profit sharing ratio (PSR). The allocation of profits between the partners is presented in the appropriation account. The appropriation, or ‘sharing out’, account appears after the calculation of net profit. In other words, we add a section at the bottom of the sole trader’s trading and profit and loss account.
So we now have the trading and profit and loss and appropriation account.
These accounts represent the long-term capital invested into the partnership by the individual partners. when new partners join a partnership it is conventional for them to ‘buy their way’ into the partnership. This initial capital introduction can be seen as purchasing their share of the net assets of the business they have joined. This initial capital remains unchanged in the accounts unless the partners specifically introduce or withdraw long-term capital. It represents the amount which the business owes the partners.
In contrast to the capital accounts, current accounts are not fixed. Essentially, they represent the partners’ share of the profits of the business since they joined, less their withdrawals. In basic current accounts, the main elements are the opening balances, salaries, profit for year, drawings and closing balances.
These elements are set out in below photo